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Part II: Expenses

Capitalizing Costs of Property

 If you produced real or tangible personal property or acquired property for resale, certain expenses attributable to the property generally must be included in inventory costs or capitalized. In addition to direct costs, producers of inventory property generally must also include part of certain indirect costs in their inventory. Purchasers of personal property acquired for resale must include part of certain indirect costs in inventory only if the average annual gross receipts for the 3 prior tax years exceed $10 million. Also, you must capitalize part of the indirect costs that benefit real or tangible personal property constructed for use in a trade or business, or noninventory property produced for sale to customers. Reduce the amounts on lines 8 through 26 and Part V by amounts capitalized. See Publication 538, Accounting Periods and Methods, for a discussion of uniform capitalization rules.

Exception for certain producers: Producers who account for inventoriable items in the same manner as materials and supplies that are not incidental can currently deduct expenditures for direct labor and all indirect costs that would otherwise be included in inventory costs. See Part III for more details.

Exception for creative property: If you are a freelance artist, author, or photographer, you may be exempt from the capitalization rules. However, your personal efforts must have created (or reasonably be expected to create) the property. This exception does not apply to any expense related to printing, photographic plates, motion picture films, video tapes, or similar items. These expenses are subject to the capitalization rules. For details, see Uniform Capitalization Rules in Publication 538.

Line 9 – Car and truck expenses: You can deduct the actual expenses of operating your car or truck or take the standard mileage rate. This is true even if you used your vehicle for hire (such as a taxicab). You must use actual expenses if you used five or more vehicles simultaneously in your business (such as in fleet operations). You cannot use actual expenses for a leased vehicle if you previously used the standard mileage rate for that vehicle. You can take the standard mileage rate for 2016 only if you:

Reporting a standard mileage rate deduction: If you take the standard mileage rate:

Enter the total on line 9. You cannot deduct depreciation, rent or lease payments, or your actual operating expenses if you take a deduction based on the standard mileage rate.

Reporting actual expenses: If you are deducting actual expenses:

Information on your vehicle: If you claim any car and truck expenses, you must provide certain information on the use of your vehicle by completing one of the following.

1. Complete Schedule C, Part IV, or Schedule C-EZ, Part III, if:

(a) you are claiming the standard mileage rate, you lease your vehicle, or your vehicle is fully depreciated, and

(b) you are not required to file Form 4562, Depreciation and Amortization, for any other reason.

If you used more than one vehicle during the year, attach a statement with the information requested in Schedule C, Part IV, or Schedule C-EZ, Part III, for each additional vehicle.

2. Complete Form 4562, Part V, if you are claiming depreciation on your vehicle or you are required to file Form 4562 for any other reason (see Line 13, below).

Line 11 – Contract labor: Enter the total cost of contract labor for the tax year. Contract labor includes payments to persons you do not treat as employees (for example, independent contractors) for services performed for your trade or business. Do not include contract labor deducted elsewhere on your return, such as contract labor includible on line 17, 21, 26, or 37. Also, do not include salaries and wages paid to your employees; instead, see Line 26, later.

You must file Form 1099-MISC, Miscellaneous Income, to report contract labor payments of $600 or more during the year. See the Instructions for Form 1099-MISC for details.

Line 12 - Depletion: Enter your deduction for depletion on this line. If you have timber depletion, attach Form T (Timber). See chapter 9 of Publication 535, Business Expenses, for details.

Line 13 - Depreciation and Section 179 expense deduction: Depreciation is the annual deduction allowed to recover the cost or other basis of business or investment property having a useful life substantially beyond the tax year. You can also depreciate improvements made to leased business property. However, stock in trade, inventories, and land are not depreciable.

Depreciation starts when you first use the property in your business or for the production of income. It ends when you take the property out of service, deduct all your depreciable cost or other basis, or no longer use the property in your business or for the production of income.

You can also elect under Section 179 to expense part or all of the cost of certain property you bought in 2016 for use in your business. See the Instructions for Form 4562 and Publication 946 to figure the amount to enter on line 13.

When to attach Form 4562: You must complete and attach Form 4562 only if you are claiming:

 If you acquired depreciable property for the first time in 2016, see Publication 946.

Listed property: Listed property generally includes but is not limited to:

Listed property does not include:

For purposes of these exceptions, a portion of your home is treated as a regular business establishment only if that portion meets the requirements under Section 280A(c)(1) for deducting expenses for the business use of your home.

Depreciation on listed property is subject to recapture if the business use percentage of any listed property dropped to 50%. See line 6 for information on reporting depreciation recapture.

Line 14 – Employee Benefit Programs: Deduct contributions to employee benefit programs that are not an incidental part of a pension or profit-sharing plan included on line 19. Examples of employee benefits programs are accident and health plans, group-term life insurance, and dependent care assistance programs.

Dependent care assistance program: If you made contributions on your behalf as a self-employed person to a dependent care assistance program, complete Form 2441, Child and Dependent Care Expenses, Parts I and III, to figure your deductible contributions to that program.

Group-term life insurance: You cannot deduct contributions you made on your behalf as a self-employed person for group-term life insurance.

Contributions to an accident and health plan: Do not include on line 14 any contributions you made on your behalf as a self-employed person to an accident and health plan. However, you may be able to deduct on Form 1040, line 29, or Form 1040NR, line 29, the amount you paid for health insurance on behalf of yourself, your spouse, and dependents, even if you do not itemize your deductions.

Small employer health insurance premiums: You must reduce your line 14 deduction by the amount of any credit for small employer health insurance premiums determined on Form 8941, Credit for Small Employer Health Insurance Premiums. See Form 8941 and its instructions to determine which expenses are eligible for the credit.

Line 15 – Insurance: Deduct premiums paid for business insurance on line 15. Deduct on line 14 amounts paid for employee accident and health insurance. Do not deduct amounts credited to a reserve for self-insurance or premiums paid for a policy that pays for your lost earnings due to sickness or disability. For details, see chapter 6 of Publication 535, Business Expenses.

Lines 16a and 16b - Interest

Interest allocation rules.   The tax treatment of interest expense differs depending on its type. For example, home mortgage interest and investment interest are treated differently. “Interest allocation” rules require you to allocate (classify) your interest expense so it is deducted (or capitalized) on the correct line of your return and receives the right tax treatment. These rules could affect how much interest you are allowed to deduct on Schedule C or C-EZ.

Generally, you allocate interest expense by tracing how the proceeds of the loan were used. See chapter 4 of Publication 535, Business Expenses, for details.

If you paid interest on a debt secured by your main home and any of the proceeds from that debt were used in connection with your trade or business, see chapter 4 of Publication 535 to figure the amount that is deductible on Schedule C or C-EZ.

How to report: If you have a mortgage on real property used in your business (other than your main home), enter on line 16a the interest you paid for 2016 to banks or other financial institutions for which you received a Form 1098 (or similar statement). If you did not receive a Form 1098, enter the interest on line 16b.

If you paid more mortgage interest than is shown on Form 1098, see chapter 4 of Publication 535 to find out if you can deduct the additional interest. If you can, include the amount on line 16a. Attach a statement to your return explaining the difference and enter “See attached” in the margin next to line 16a.

If you and at least one other person (other than your spouse if you file a joint return) were liable for and paid interest on the mortgage and the other person received the Form 1098, include your share of the interest on line 16b. Attach a statement to your return showing the name and address of the person who received the Form 1098. In the margin next to line 16b, enter “See attached.”

If you paid interest in 2016 that also applies to future years, deduct only the part that applies to 2016.

Table of Contents

Capitalizing Costs

Line 9 – Car and truck expenses

Line 11 – Contract Labor

Line 12 – Depletion

Line 13 – Depreciation and Section 179 Expenses

Line 14 – Employee Benefit Programs

Line 15– Insurance

Line 16 – Interest

Line 17 – Legal and Professional Services

Line 18 – Office Expenses

Line 19 – Pensions and Profit Sharing Plans

Line 20 – Rent and Lease Expenses

Line 21 – Repairs and Maintenance

Line 22 – Supplies

Line 23 – Taxes and Licenses

Line 24(a) – Travel

Line 24(b) – Meals and Entertainment

Line 25 – Utilities

Line 26 – Wages

Line 27a – Other Expenses

Line 30 – Expenses for the Business Use of the Home

Line 31 - Net Profit

Line 32 - At-Risk Limitation

Chapter 20  Schedule C: Expenses, Page 1